Growth and inequality : a trade-off? Remarks by Iyanatul Islam, Adjunct Professor, Griffith Asia Institute, Griffith University, Brisbane, Australia and former Branch Chief, ILO, Geneva and Global Conference on “Prosperity, Equality and Sustainability: Perspectives and Policies for a Better World”, 1-3 June 2016 at New Delhi, Institute for Human Development and World Bank 1

Growth and inequality: preamble Increasing inequality is a global phenomenon (Solt, 2014) Rising inequality in USA is well known In OECD, 16 out of 21 countries experienced growing inequality between 1985 and 2011 In South Asia, the major economies of the region have witnessed growing inequality in the 2000s Inequality in the region in 2010 is significantly higher than 1975 Graphs>>>>> 2

Inequality trends: USA (net income) 3

Inequality trends: South Asia (net income) 4

Growth and inequality: competing perspectives One view – associated with the early post-Keynesian literature– suggests that higher inequality promotes growth (Rodriguez, 2000 drawing on Kaldor, 1960 and Kalecki, 1971) The most commonly used justification is that the rich save more than the poor Hence, asset concentration leads to more saving, more investment and more growth 5

Growth and inequality: competing perspectives A variation of this argument is the so-called ‘increasing returns to investment’ thesis Minimum investment in education, up to secondary schooling for example, is necessary before the impact of education on growth can be realized In that case, asset concentration is necessary to deal with increasing returns to investment 6

Growth and inequality: competing perspectives One could also invoke political economy arguments A high degree of inequality motivates demands for redistribution that distorts work incentives through higher taxes and transfer payments Reduced work incentives can retard growth 7

Growth and inequality: competing perspectives These pro-inequality arguments can be contested One could argue that inequality breeds political and social instability and can retard growth Lower inequality seems to be associated with lower fertility which increases growth in a conventional neoclassical model Inequality in the presence of credit market imperfections can retard growth This happens because the poor are deprived from opportunities to accumulate human and physical capital 8

Growth and inequality: empirical evidence Kuznets (1955) and his pioneering empirical work led to the notion of a short-run trade off between growth and inequality Inequality first rises and then declines as economic development takes place Widely accepted in the 1970s, validated by Barro in the 1990s (Barro, 1999) Hence…inequality retards growth in poor countries, but encourages growth in rich countries 9

Growth and inequality: empirical evidence New empirical evidence supports the view that more unequal societies grow less rapidly (The Economist, 2014) This evidence is influenced by a series of papers, such as Berg et al (2011, 2014) Latin America, for example, has a Gini ratio of 50 vs Asia whose average is 40 If Latin America could close half this gap, its typical growth spell would be twice as long 10

Growth and inequality: empirical evidence OECD (2014) contends that an increase in the Gini of three points reduces annual growth by 0.35 percentage points over a period of 25 years The net impact is a cumulative loss of GDP of 8.5 per cent Berg et al (2014), using global data, find a similar result: a rise in Gini of five points can retard annual growth by 0.5 percentage points 11

Growth and inequality: Policy issues The growth-inequality nexus is policy-contingent Some policies can promote both growth and equity Others can promote growth, but this can be offset by an increase in inequality Examples? Suppose a government engages in tax reform by cutting income and corporate taxes in a bid to boost growth and employment. What is the likely outcome? 12

Growth and inequality: Policy issues Studies show that, while there might be a modest increase in growth and employment, the impact on income distribution is deleterious OECD data suggest that a 1% cut in corporate and income taxes will boost employment by only 0.05 per cent at best (Bova et al 2014) If Gini goes up by 1 point as a result growth in the next round is expected to drop by 0.1 per cent (OECD 2014) Hence, initial growth gains are more than fully offset 13

Growth and inequality: Policy issues If a country engages in fiscal consolidation regardless of the state of the business cycle, growth will decline and inequality will go up Recent experience of Euro Area is consistent with this interpretation (Ranenberg, 2015) Fiscal consolidation of approx. 4 per cent of GDP between 2011 and 2013 reduced growth by up to 3.5 per cent 14

Growth and inequality: policy issues Data from 17 OECD countries ( ) period suggest that following fiscal consolidation episodes (Ball et al 2013): (a) long run inequality goes up by 3.4 per cent (b) wage share declines in long run by of 0.8 percentage points (c) long run unemployment goes up by 0.5 per cent 15

Growth and inequality: Policy issues What policies are likely to promote both growth and equity? A sustainable domestic resource mobilization strategy that supports investment in health, education, infrastructure and social protection can help the cause of equitable and inclusive growth If well-designed environmental taxes are used as part of harnessing sustainable fiscal space to promote equitable growth, they can also support the goal of environmental protection This can be complemented by a financial inclusion strategy 16

Growth and inequality: policy issues Such a policy framework can also promote jobs through direct employment effects and by boosting employability For example, the employment multiplier associated with government expenditure is around 0.4 (Bova et al 2014) In sum, there need not be a trade-off between growth and inequality Policies can be designed to promote a ‘better world’ 17

References Ball, L et al (2013) ‘The distributional effects of fiscal consolidation’, IMF Working Paper No.151 Barro, R (1999) ‘Inequality, growth and investment, NBER Working Paper No.7038 Berg, A et al (2011) ‘ Inequality and unsustainable growth: two sides of the same coin’? April, IMF Discussion Note Berg, A et al (2014) ‘Redistribution, inequality and growth’, IMF Staff Discussion Note, February Bova, E et al (2014) ‘ A fiscal job’? Fiscal policy and the labor market’, IMF Working Paper No.216 Kaldor, N (1960) Essays on value and distribution, Free Press: Glencoe, Ill. Kalecki, M (1971) Selected essays on the dynamics of the capitalist economy, Cambridge: Cambridge University Press Kuznets, S (1955) ‘Economic growth and income inequality’, American Economic Review, 45, pp OECD (2014) ‘Focus on inequality and growth’, Directorate of Employment, Labour and Social Affairs Ranenberg, A (2015) ‘The consequences of Europe’s fiscal consolidation’, World Economic Forum, November 16 Rodriguez, F (2000) ‘ InBall, L et al (2013) ‘The distributional effects of fiscal consolidation’, IMF Working Paper No.151 equality, economic growth and economic performance’,: A background note for the World Development Report 2000 Solt, F (2014) ‘The Standardized World Income Inequality Database’ Working paper. SWIID Version 5.0, October The Economist (2014) ‘Growth v Inequality’, March 1, 18